Daily Development for Friday, August 16, 2002

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

LANDLORD/TENANT; PERCENTAGE RENT; SUBLETS: Percentage rent in master lease will be determined on the basis of gross sales activity of sublessee, rather than sublease rentals.

Bombay Realty Corp. v. Magna Carta Inc., 741 N.Y.S.2d 318 (A.D 3 Dept. 2002), also discussed under the heading: "Landlord/Tenant; Percentage Rent; Commissionable Sales."

This conclusion is implicit in this case, which deals with the amount of rent payable under the master lease, even though, apparently due to the special language of the sublease, the subtenant was liable to pay the master lease rent. Milton Friedman, in his treatise Friedman on Leases, notes that the issue of whether a subtenant's business is includable in the gross rent determination is something that the parties ought to address specifically in the lease, but that in most cases the courts conclude that the parties intend that it be included. See Friedman on Leases, Section, 6.4, 6.401. (4th Ed. 1997). See Joseph Bros. Co. V. F.W. Woolworth Co., 641 F. Supp. 822 (N.D. Ohio 1985).

LANDLORD/TENANT; PERCENTAGE RENT; COMMISSIONABLE SALES: Percentage rent provision under lease required tenant to pay rent on the total value of telephone service plans sold on the premises as opposed to the commission generated thereby.

Bombay Realty Corp. v. Magna Carta Inc., 741 N.Y.S.2d 318 (A.D 3 Dept. 2002), also discussed under the heading: "Landlord/Tenant; Percentage Rent; Sublets."

This case involves a sublease, but this discussion assumes that the sublessee was bound to pay the rent on the master lease under the same terms as the original tenant, as this appeared to be the way the court treated the case, likely due to language in the sublease that the court does not mention. The master lease, which originally was drafted for a fast food operation, required the payment of added rent on the basis of a percentage of gross sales of tenant's business.

The court ruled that a sub-tenant with a business that generated profits in a manner different than that of tenant is not entitled to the re-formulation of the added rent calculation. Such a re-formulation would derive the landlord of its reasonably expected return on investment.

The language of the lease defined "gross sales" as:

"The income generated by the business conducted by the LESSEE on the demised premises, including income derived from the sale of all services and all products whether for cash or for credit [less taxes]."

The court noted that the commissions derived from the sales of the calling plans were the equivalent of profits from sales, and that this would convert the percentage rent to a percentage of net, rather than gross, proceeds. It commented that this would have the effect of depriving the landlord of its reasonably expected return on its investment. It did not matter that the gross amounts of the sales were actually based upon services provided by another party, which presumable had its own profit margin built into the price. The court commented:

"The fact that the product sold by [tenant] is actually supplied by another party strikes us as irrelevant and any hardship created by respondents own commission structure is one that respondent accepted with full advance knowledge of the governing lease provisions."

Further, it didn't matter that the services sold were provided off the premises where the sales occurred.

Comment 1: In Elfstrom v. Brown, 366 P.2d 728 (Or. 1961), a landlord was able to collect rent based upon the gross income of a painting and roofing business, even though the services were performed off the premises where the sales were made. Further, sales made on premises through telephone orders but fulfilled off premises were held to be part of "gross sales." Krieger v. Elkins, 620 P.2d 370 (Nev. 1980). Wal-Mart dodged a missile when a court ruled that a lease providing for a percentage of "Gross Sales . . . whether such sales be obtained at the demised premises or elsewhere . . ." did not mean that Wal-Mart owed rent based upon the gross amount of its world wide operations. The court found such an interpretation "preposterous," although it offered no other rational interpretation of the parties' choice of this language.

Comment 2: In this characteristically pithy New York appeals court opinion, we're given very little of the language of the documents. This approach, however, to treat commission sales as part of the gross rents does appear to be the general trend, although language and context mean a lot.

Compare: In re The Circle K Corp. 98 F. 3d 484 (9th Cir. 1996) and cases cited, which stands for the proposition that where lottery ticket sales become legal and, as a practical matter, essential to a convenience store's operation, all after the lease is entered into, the commissions, but not the gross proceeds of the lottery ticket sales, will be included in the gross sales computation. The result might be different if the lease is executed after lottery sales are initiated in the jurisdiction..

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